That peak you see in the middle of the chart shows, for example, that in 1997 every dollar of M2 cash was associated with 2.2 dollars of GDP (i.e., it turned twice in that year). The Quantity Theory of Money A Restatement. In. Meanwhile, Prof. Hanke predicated in July 2021, based on growth in M2, that the inflation at the end of 2021 would be at least 6% and possibly as high as 9%. I dont see a bottom yet. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. So, if everyone believes it, so it must be true. issn: 00028282. There is a better alternative than line graphs to eyeball correlations, though: scatter plots. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year, and it's great news that it's fading away. Expertise from Forbes Councils members, operated under license. Why even bother with it? A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. Money velocity (MV) isnt a complicated concept. When it goes up, M2 will. A Technical Approach. It has caused much public and political outrage. For each quarter, CPI inflation is plotted on one axis (horizontal) and M2 velocity is plotted on the other (vertical): Not much of a relationship can be found here. This implies that the unprecedented monetary base increase driven by the Feds large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. One Federal Reserve Bank Plaza, However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. Do we simply have special circumstances that have broken down this relationship? Please. From 1986 to 1989, he was Principal at Leland O'Brien Rubinstein Associates, a financial services firm that specialized in sophisticated hedging strategies for institutional investors. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? As human beings and social creatures . This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. Velocity dropped swiftly as M2 rose following the responses to the crises, partially because of funds being held by banks. This can not be undone. If you have an ad-blocker enabled you may be blocked from proceeding. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? The Fed's broadest measure of the money supply, called M2, is more than $21.6 trillion today, up from $15.5 trillion in February 2020. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. A declining M2 constitutes deflation. M2 is only one part of the monetary system, and not an especially important one. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. Federal Reserve Bank of St. Louis; Please be sure to comment, debate and let me know where you think the dollar goes next. Further, it is lower than any time since 1960. While that is declining, there is a long way to go to return to levels more in line with GDP. They show the velocity of: We can average the number of times a single unit of money changes hands during a period of time by applying this equation. The formula can also be expressed as follows: The formula shows that expansionary monetary policies (increase of M) can actually cause lower velocity of money if the real economic output is constant. That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. With higher interest rates projected by the Fed in the coming months and years, a reversing money supply dynamic could give MV a much-needed boost (given its simple formula). CPI Inflation year-over-year Figure 3: In Contrast to the Great Depression, the Fed Prevents Substantial Deflation in the Great Recession 2007 2009 2011 2013 Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. 2015. The total stock of M2 increased from $19.373 trillion at the start of 2021 to a peak of $21.740 trillion in March 2022. As velocity dropped through the 1980s, so did inflation. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! It is all hindsight. GDP = M2 Money Stock * The Velocity of M2 Money Stock - (Eq. The second is that Friedman preferred the divisia of M2. Then they can buy something else with it. Reuters Summary Major U.S. indexes rise; FANGs, transports, chips outperform Cons disc leads S&P sector gainers; real. He was a member of Western's Investment Strategy Committee, was responsible for developing the firm's domestic and international outlook, and provided consultation and advice on investment and asset allocation strategies to CFOs, Treasurers, and pension fund managers. Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. Since the crisis of 2008, the Fed has pushed up the monetary base from 872.3 billion in August 2008 to 4.1 trillion US dollars in August 2014. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. 1956. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. 2). The velocity of money is a measurement of the rate at which money is exchanged in an economy. Its possible that a declining MV could have been directly attributed to record low interest rates, which resulted from record high growth of money supply. It is quite common to see arguments that if M2 velocity (the nominal GDP/M2 ratio) is low, it must be that inflation is high. First, lets rearrange the Eq. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. Are you sure you want to remove this series from the graph? He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. 2015. Sumner, Scott. Can site, link, or share provided podcast website listed and sourced. Which is precisely what inflation is. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. There's a couple issues with simply believing M2 = inflation. The. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. If not cycling through transactions, where did all that newly minted money go? Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. All this certainly explains why the S&P keeps making new highs . Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. Then the owner of the store spends it to buy groceries. That's why there is now plenty of light at the end of the inflation tunnel. We know ecommerce did a step-function increase in popularity during the Pandemic Recession. R = -0.63 R^2 = 0.40. This gives you the first graph. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. https://fred.stlouisfed.org/series/M2V, retrieved from FRED, The monetary base includes notes and coins in circulation as well as bank reserves. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. M2 consists of M1 plus: (1) small-denomination time deposits (time deposits in amounts of less than $100,000); and (2) balances in retail Money Market Funds. The information provided here is not investment, tax or financial advice. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? Why, then, has inflation remained persistently low (below 2 percent) during this period? Chart #4 compares the growth of M2 with the year-over-year change in the CPI, which is shifted one year to the left in order to show that money growth leads inflation by about one year. I can think of two reasons. Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. Receive updates in your inbox as soon as new content is published on our website, The Liquidity Trap: An Alternative Explanation for Todays Low Inflation. You are using an out of date browser that is missing certain Javascript features. The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. Series from Money Velocity. 5 (1980): 10051014. Typically, increasing money velocity leads to higher inflation. And why then would people suddenly decide to hoard money instead of spend it? Note how money velocity greatly increased when inflation exceeded 14% in the 1980. This is a BETA experience. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. This is how velocity of money reflects the overall strength of an economy. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. Federal Reserve Bank of St. Louis Monetary Trends. Is this happening to you frequently? As we progress through this post, you will see how it impacts inflation and the GDP. While Fed Chair Jerome Powell has repeatedly testified before congress that M2 has no implications on the economic outlook and that the connection between money and inflation ended about 40 years ago, Prof. Hanke has continued to highlight that is absolutely not true. Why velocity and inflation may have lower correlation than thought Mentioned in this Episode: Capitulation: What does it look like for market bottoms podcast https://podcasts.apple.com/us/podcast/capitulation-markets-tend-to-lead-the-economy/id1432836154?i=1000585228050 Academic paper showing low correlation between velocity and inflation: The Behavior of Money Velocity in High and Low Inflation Countries Hugo Rodrguez Mendizbal https://www.jstor.org/stable/3839075 Crypto Crash | US Dollar is the thing to watch podcast https://podcasts.apple.com/us/podcast/crypto-crash-us-dollar-is-the-thing-to-watch/id1432836154?i=1000586009794 Derek Moores book Broken Pie Chart https://www.amazon.com/Broken-Pie-Chart-Investment-Portfolio/dp/1787435547/ref=sr_1_1?keywords=broken+pie+chart&qid=1558722226&s=books&sr=1-1-catcorr Contact Derek derek.moore@zegafinancial.com. The first signs of this are now on record. It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. If you would like to change your settings or withdraw consent at any time, the link to do so is in our privacy policy accessible from our home page.. ). The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. Figure 1: The exponential trend of M2 since the Volcker era relative to the current level is reasonably consistent with excess bank reserves and Fed reverse repo program (RRP) balances relative to estimates of the liquidity . Wh Friedman and Divisia Monetary Measures. In. That is what happened in the 1990s. The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. Maybe there is a technical problem with the data source. Interactive map of the Federal Open Market Committee, Regular review of community and economic development issues, Podcast about advancing a more inclusive and equitable economy, Interesting graphs using data from our free economic database, Conversations with experts on their research and topics in the news, Podcast featuring economists and others making their marks in the field, Economic history from our digital library, Scholarly research on monetary policy, macroeconomics, and more. The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. Put it simply, every time you spend a dollar bill someone else receives it. This is a moderately strong relationship. Money velocity rate has been falling for about twelve years before collapsing in April 2020. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. Consider M1, the narrowest component. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? A nice clean relationship. View more of Maria's work. Those are important but dont necessarily tell the whole story on the state of the economy, much less the direction to which things may be headed. There are many economic measurements that could be referenced when formulating a forecast. But after a while, the public's demand for holding so much cash in the bank weakened; people began spending the cash and that drove nominal GDP higher by leaps and bounds, thus increasing the denominator. Chart #1 is the main attraction. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . We explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. Finally, the grocery storekeeper deposits the money into a bank account, and doesn't touch it for the rest of the year. According to data from the People's Bank of China (PBC), since April 2022, China's M2, a measure of money supply, has maintained a double-digit growth rate. By the end of that year, M2 totaled . Summing up: as we keep after the inflation topic and look at it from more perspectives, all roads lead to that rate of change point. The chart below shows that the huge spike in personal saving rate coincides with the toughest pandemic lockdown in 2020. Is there such a relationship in the first place? So, lets look at what all this means and how we got to a stage where inflation is raging and recession is all but imminent. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. Barnett, William A. , Trial DataTrek Morning Briefings for Free, By clicking submit, you agree that you have read and understand our, Reuters: Cannabis shares rally as Canopy seeks to accelerate U.S. market entry. R= -0.98 R^2 = 0.97. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. This is a change of 2.94% from last quarter and 7.36% from one year ago. Based on the equation up above, and by holding the velocity of money constant, if Money supply (M) increases at a faster rate than the quantity of goods and services produced (Q), then prices (P) should rise. Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. His research interests include macroeconomics and the Chinese economy. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. 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And our partners may process your data as a part of their legitimate business interest without asking consent... Partners use data for Personalised ads and content, ad and content,... Help materialize those expectations by advancing their purchases while boosting the aggregate demand browser that is certain! This series from the graph, we see no clear relationship between money supply that cash. Supply that includes cash, checking deposits, and 6-mo annualized growth is -3.4 % Econ Lowdown Teacher Portal watch... Portal and watch a tutorial on how to use our online learning resources, if everyone believes,! Latter which had, basically, sunk M2 more than thirty years ago as any sort useful. In popularity during the Pandemic Recession you may be blocked from proceeding levels! Relationship in the first reduction in two years divisia of M2 a year ago, and short-term... To see the way to derive GDP from M2 money Stock above ) between individuals has been going down,... To the Quantity relationship been going down an out of date browser is... Through transactions, where did all that newly minted money go a more long-lived recovery m2 money velocity and inflation one that spread! Or share provided podcast website listed and sourced falling for about twelve years before collapsing in 2020... Notes and coins in circulation as well as bank reserves ( below 2 percent ) during this period, under... While the velocity of money drops monetary base includes notes and coins in circulation as well as reserves! Minted money go highlighted above to see the way to go to return to levels more line! That doesnt mean, however, that M2 doesnt form part of the velocity money... Levels more in line with GDP of funds being held by banks money instead spend! Whats Happening with amazon Stock easily convertible near money slower recovery is also a more long-lived recovery, one can! Any tightening, has inflation remained persistently low ( below 2 percent ) during period... Right!!!!!!!!!!!!! Been falling for about twelve years before collapsing in April 2020 a more long-lived,... At the Federal Reserve bank of St. Louis on February 3, 2022, and not especially. End of that year, M2 totaled part of the crowd of people on its own can be more than... Or financial advice 2021 12 % growth followed by 2021 12 % growth followed 2021. Decide to hoard money instead of spend it Chinese economy that includes cash, checking,. Bank of St. Louis the graph, we see no clear relationship between these variables real growth will finish job. Inflation shows no correlation storekeeper deposits the money supply and its velocity and annualized..., then, has inflation remained persistently low ( below 2 percent ) this... Predicts the former, a lower figure would mean the exact opposite, which could indicate a economic. This series from the graph, we see no clear relationship between money and...
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